AMERICAN BAR ASSOCIATION FORUM ON AFFORDABLE HOUSING AND COMMUNITY DEVELOPMENT 2017 ANNUAL MEETING TAX CREDIT DISCUSSIONS WITH IRS, TREASURY AND CDFI

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1 AMERICAN BAR ASSOCIATION FORUM ON AFFORDABLE HOUSING AND COMMUNITY DEVELOPMENT 2017 ANNUAL MEETING TAX CREDIT DISCUSSIONS WITH IRS, TREASURY AND CDFI May 24, 2017 PANEL 1 LOW-INCOME HOUSING TAX CREDIT AND PARTNERSHIP AUDIT ISSUES 2:00pm - 3:15pm PANEL 2 NMTC AND HISTORIC TAX CREDIT ISSUES 3:30pm - 5:00pm 1

2 PANEL 1 LOW-INCOME HOUSING TAX CREDIT AND PARTNERSHIP AUDIT ISSUES General: LIHTC 1. Update on completed and outstanding guidance projects? 2. Are there any particular issues that have become a focus or area of concern on audits? 3. To what extent are process changes anticipated under the new administration? Other Tax Issues: 1. Report from General Accounting Office - Over the last three years, the General Accounting Office issued a series of reports on how they saw the IRS and the State Housing Finance Agencies administer and over the tax credit program. The last report talked about the role of the syndicator. - The reports offered some recommendations for how they thought the program could be administered more effectively. - Does the IRS foresee any changes to the process in response to these reports? 2. Partnership Audit Procedures a. New Audit Rules: Section 1101 of the Bipartisan Act of 2015 (HR 1315) repeals the partnership audit rules of the Tax Equity and Fiscal Responsibility Act of 1982 and replaces them with a new set of audit rules. We understand that the IRS had planned to issue regulations, but the regulations were withdrawn when the new president took office. Can you provide any update on when the IRS will issue guidance on the new audit rules and what form that guidance will take? Will the guidance be in the form of regulations or notices or something else? Should we expect any guidance from the IRS to look like the regulations that appeared just before they were withdrawn? Has the IRS received any useful comments? Are technical corrections to the Code provisions expected? 2

3 Issues that taxpayers and practitioners are considering i. What was the motivating force behind these new provisions? Did the IRS outline or design them? Does the IRS envision a significant increase in partnership audits? For example, at the $100M of assets level (an amount that is higher than most, but not all, of our credit deals), the GAO reports that 27% of corporations but only 1% of partnerships are audited. Is that expected to change? ii. The "regulations" provided that once an individual was designated the partnership representative, they could only be changed if and when the IRS commenced an examination. It should be expected that people will retire or die, and it should be possible to replace them at that time. Otherwise, the IRS may send a notice to someone who is not capable of receiving it, and the taxpayer will never have notice of the audit. iii. The "regulations" provided that if an entity was the partnership representative, then the entity had to designate an individual, and that person had to stay the designee unless and until an examination commenced. This leads to the same comment as above. In addition, this prevents certain entities that should be particularly good at keeping track of notices, like trust companies, will have to pass everything to individuals, making the use of an entity irrelevant. iv. It appeared that the 'IRS believes it is empowered to go after the partners, even if no election is made, if the partnership has insufficient assets to satisfy its tax liability. Barring a fraudulent conveyance, the IRS could not do this with a corporation, and this seems an expansion beyond the scope of the Code provision. 3. Planned Foreclosures Situations where after the 15-year compliance period, a general partner or related party then records a mortgage in favor of a related party (or acquires such debt from another parties). The project then goes into default (which may be on purpose or not on purpose). The project is then transferred to the related party lender via a deed-in-lieu of foreclosure which terminates the extended use restrictions. Section 42 does address this issue by prohibiting the termination of the extended use agreement where the Secretary determines that such acquisition is part of an arrangement with the taxpayer a purpose of which is to terminate such period. Section 312 of S.548 Affordable Housing Credit Improvement Act of 2017 called the Cantwell-Hatch Bill, proposes (1) a 60 day waiting period before termination of LIHTC restrictions, (2) have the Credit Agencies, rather than the IRS, make the determination as to whether the transfer was a planned foreclosure, and (3) allows Credit Agencies to have more stringent requirements than the foregoing. 3

4 Questions: a. Has the IRS ever determined that a foreclosure or deed-in-lieu was done with a purpose to terminate the extended use period? b. If a Credit Agency or other party (e.g. a tenant) thinks that there is an impermissible purpose situation, what is the process to notify the IRS? How would the IRS evaluate the issue? c. After the 15-year Compliance Period has ended, the IRS is normally not further involved in projects? Does the IRS have the authority to delegate this determination to the Credit Agencies? 4. Changes in Accounting Methods Resulting from Cost Segregation Studies A cost segregation study can be done to allocate the costs of assets previously placed in service to appropriate recovery periods. That could result in moving some costs from a 27 ½ year life to a shorter life, and perhaps to a more accelerated depreciation method. If this is done in a year after the property was placed in service, the taxpayer would need to compute a catchup adjustment that looks at how much depreciation was taken under the old method and comparing that with the appropriate amount of depreciation (post cost segregation). Generally, an accounting method change to fix depreciation is done by filing an automatic accounting method change request (Form 3115). While the type of change is still generally automatic, the IRS recently created an exception where the change involves property on which the taxpayer took a federal tax credit. This could involve a variety of federal tax credits including the LIHTC. Other credits include the HTC and the credit under 168(k)(4) (AMT credit in lieu of bonus depreciation). Therefore, pursuant to Revenue Procedure , for properties on which the LIHTC was taken, the IRS now requires that the taxpayer submit a request for advanced approval of a change in accounting. It seems that the IRS made this change because there were assets included in historic tax credit eligible basis (so treated as real property and historic credit eligible) that were later (after the recapture period lapsed) reclassified as personal property or site improvements, neither of which would qualify to be included in historic basis. As a result of the revisions to the accounting method change procedures, the taxpayer must file federal form 3115 in advance (i.e., before the last day of the tax year of change) and secure IRS approval. This changes not only requires a taxpayer to file the Form 3115 earlier, but also requires the taxpayer to pay a large IRS user fee. Would the IRS consider allowing a taxpayer to make this change without permission if it does not restate assets that were included in historic basis into personal property or site improvements? Unlike the historic basis, each class of property is included in eligible basis. Therefore, a change in the class of the property would not result in a change in eligible basis. 4

5 5. Non-Profit Right of First Refusal In Section 42(i)(7) Congress stated that no tax benefits would be lost if a tenant, Qualified Nonprofit Organization (a housing 501(c)(3) or 501(c)(4)) or governmental agency had the right of first refusal to buy a building after the end of the Compliance period for a price that is no less than the buildings debt plus exit taxes. a. For Section 42 purposes, is there a difference between a right of first refusal and a purchase option? b. Is it consistent with Section 42(i)(7) to have a limited partner and a general partner that is a qualified nonprofit agree that the right of first refusal can be exercised at the end of the 15-year Compliance Period? c. In order to fall within Section 42(i)(7), does a ROFR need to require a bona fide third party offer be made in order to activate the ROFR? How can such an offer be obtained if any potential buyer will know that a nonprofit can swoop in and buy the property for a bargain price of just debt plus taxes? d. Would it be possible to get guidance on this issue? 6. Substantially Federally Assisted Guidance In order to qualify for acquisition credits, generally a building cannot have been placed in service for the last 10 years. In 2008 Congress enacted Section 42(d)(6) which provides an exception from the 10-year rule for buildings that are substantially federally or state assisted defined at substantially assisted, financed or operated. a. Does the IRS contemplate issuing any formal guidance on federally assisted projects for purposes of determining whether the ten year rule applies? b. In the meantime, is there any informal guidance that can be offered? Without guidance, there are transactions that are not moving forward due to the lack of certainty and risk of claiming acquisition credits. i. How much of a Project needs to be subject to a Section 8 contract in order to be considered Substantially Federally Assisted? Is substantial less than a majority? How about 20%, 33%, or 50%? ii. Does a Section 8 contract need to be in place prior to and after acquisition or can one be entered into as part of the acquisition? iii. Does Federal loan entered into when a property is acquired count? Does an existing Federal loan count if it is paid off at acquisition? 5

6 7. Scattered Site Project: There has been some concern as to whether 100% of the units in a scattered site project need only be rent restricted, or must they also be occupied by tenants who meet the applicable income limitations. While the Code seems clear in requiring only rent restriction, the Audit Guide seems to be conflicted, requiring that the units be low-income units in one place (meaning income and rent restricted) and only rent restricted in another place. Although the Audit Guide is not formal guidance, it is relied upon by people in the industry and has resulted in some unnecessary relocation of tenants in some project and loss of equity to other projects. a. Section 42 Analysis i. Section 42(g)(7) provides the following for Scattered Site Projects : Buildings which would (but for their lack of proximity) be treated as a project for purposes of this section shall be so treated if all of the dwelling units in each of the buildings are rent-restricted (within the meaning of paragraph [42(g)](2)) residential rental units. ii. Section 42(i)(3) defines a "Low-Income Unit" as a unit that is: rent-restricted as defined in 42(g)(2), and occupied by individuals meeting the income limitations under 42(g)(1). iii. Section 42(g)(2)(A) provides that For purposes of paragraph [42(g)](1), a residential unit is rent-restricted if the gross rent with respect to such unit does not exceed 30 percent of the imputed income limitation applicable to such unit.... iv. Section 42(g)(2)(C) provides that For purposes of this paragraph, the imputed income limitation applicable to a unit is the income limitation which would apply under paragraph [42(g)](1) to individuals occupying the unit if the number of individuals occupying the unit were as follows.... v. 42(g)(1) provides the following: The term qualified low-income housing project means any project for residential rental property if the project meets the requirements of subparagraph (A) or (B) whichever is elected by the taxpayer: vi. 42(g)(1)(A) Test - The project meets the requirements of this subparagraph if 20 percent or more of the residential units in such project are both rent-restricted and occupied by individuals whose income is 50 percent or less of area median gross income. 6

7 vii. 42(g)(1)(B) Test - The project meets the requirements of this subparagraph if 40 percent or more of the residential units in such project are both rent-restricted and occupied by individuals whose income is 60 percent or less of area median gross income. viii. Any election under this paragraph, once made, shall be irrevocable. For purposes of this paragraph, any property shall not be treated as failing to be residential rental property merely because part of the building in which such property is located is used for purposes other than residential rental purposes. ix. Summary of Statutory Analysis - Because Section 42(g)(7) only refers to units being rent-restricted, we believe that the relevant threshold for scattered site projects should be whether the rents charged on each of the units in the Project meet the requirements of Section 42. In other words, each unit needs to have rents that are restricted to 30% of either 50% or 60% of area median gross income. b. Audit Guide Page of the provides the following saying all units must be lowincome units: i. Under IRC 42(g)(3)(D), each low-income building is considered a separate project unless the taxpayer identifies each building which is, or will be, part of the project. Under IRC 42(g)(7) and Treas. Reg (b)(4)(ii), two or more qualified low-income buildings can be included in a project only if the buildings: are located on the same tract of land, unless all the units in all the scattered site buildings to be included in the project are lowincome units. c. Audit Guide Page A-8 provides the following which says units only need to be rentrestricted: i. Project, Scattered Site: Buildings which would, but for their lack of proximity, be treated as a project shall be treated as a project if all the dwelling units in all the buildings are rent-restricted residential rental units. IRC 42(g)(7). d. What is the IRS Position on what is needed for a scattered site project to be considered one project? 7

8 NEW MARKETS TAX CREDIT 1. CDFI Fund Discussion by David Meyer a. Highlights of the combined Allocation Round. i. Overview on how this combined round went/is going ii. How did the combined NMTC round influence the current allocation round, announced on May 2, 2017? b. Overview of Current Allocation Round announced May 2, 2017 i. Highlights of current NOAA for the 2017 round ii. What are the "tweaks" with this current NOAA? iii. When will the awards be announced in 2017 for this 2017 NMTC round? expected in 2017? c. Discussion regarding Certification, Compliance Monitoring and Evaluation FAQ (Initially issued in 2015, updated in April of 2017). i. Discussion regarding the 2015 Compliance FAQ, updated in April of 2017, and how were the requirements described in items 44, 45 and 46 of this FAQ determined and updated with the recent April update? ii. Impacts on the FAQ on nonprofit sponsored projects? Any further updates to the FAQ to address these financially challenged nonprofit projects? iii. Item 44 and 46 places limitations on the ability to monetize assets owned or controlled by the QALICB or an affiliate of the QALICB. How does the CDFI Fund determine how an entity is an "affiliate" of the QALICB? In particular in a nonprofit sponsored project. (see NMTC diagram regarding role of sponsor and QALICB) d. Technical Assistance Project e. Minority CDEs discussion 2. Treasury Discussion with Hannah Hawkins a. Introduction of Hannah Hawkins and Treasury's Role in the NMTC Program b. Policy Objectives Being Considered by Treasury as to the NMTC Program 8

9 3. IRS Discussion by James Holmes of the IRS a. Discussion regarding IRS Regulation Project for the NMTC Program b. Any current pressing issues on recent IRS audits of NMTC projects? Targeted Populations Review c. The IRS has recently raised some concerns regarding the relatedness of the leverage lender and the QALICB. NMTC transactions have to be structured to ensure that the QLICI debt is considered "true debt" and the relatedness of the leverage lender/sponsor and the QALICB is often a concern. Any updates from the IRS on this issues? (see NMTC diagram) d. How does the CDFI Fund, IRS and Treasury work together in regulating the NMTC Program? i. Does the IRS and Treasury have any input on CDFI guidance, like the 2015/2017 Compliance FAQ? ii. Is the IRS, Treasury or CDFI Fund considering analyzing how the NMTC Program is utilized and how NMTC projects meet policy goals (i.e. creation of jobs, providing services, community impact in low income communities, stimulating economic development)? If so, how can the NMTC community help with providing real life examples on how the NMTC program meets policy objectives and improves the lives of low income households and low income communities? 9

10 NMTC Structure David Meyer CCME - ABA Forum LEVERAGE DEBT PROVIDER EQUITY INVESTOR $720, % $390,000 NMTC INVESTMENT FUND, LLC $1,000,000 CAPITALIZATION $280,000 Equity Investor X $1,000,000 QEI CDE, LLC $390,000 NMTC Costs & Fees $50,000 ALLOCATEE Loan A 7.5% $950,000 QLICI Equity or Subordinated Debt $230,000 QALICB 10